RENEE MONTAGNE, host:
If you're like me, your financial vocabulary is now brimming with once-exotic terms like credit default swaps. This week brings another one. Suddenly on everyone's lips: the bad bank. The Obama administration is considering a new plan to help troubled U.S. banks, and one idea floated by Federal Reserve Chairman Ben Bernanke, as banks continue to experience huge losses, is to create a bad bank. And with us to explain why a bad bank might be a good idea is Simon Johnson. He's a professor at MIT and former chief economist of the International Monetary Fund. Good morning.
Dr. SIMON JOHNSON (Entrepreneurship, Global Economics and Management, Massachusetts Institute of Technology): Hi.
MONTAGNE: Let's start with bad bank. It's an interesting expression. What is a bad bank?
Dr. JOHNSON: Well, a bad bank is a way to clean up the really bad banks. All the private banks that have problem assets, take those problem assets off their books. Think of it as the biggest financial sanitation project ever.
MONTAGNE: What makes this different from the plan that former Treasury Secretary Hank Paulson put out when asking Congress for this bailout, basically having the government buy up troubled assets from financial institutions? Wouldn't they have put those assets in a bad bank?
Dr. JOHNSON: Well, that's a great question, and there would have been some aspect there if he ever got his program off the ground. The key difference, though, is that the Paulson - the original Paulson plan, the key idea of that was that you would overpay for these bad assets.
MONTAGNE: By overpaying, you would ensure that banks would be happy to unload them.
Dr. JOHNSON: That's right, exactly.
MONTAGNE: And so now, this bad bank idea does what differently?
Dr. JOHNSON: Well, the bad bank idea would be to take those assets and provide new capital, both balance-sheet cleanup and recapitalization. This is a very standard process in banking-system cleanups all around the world, when they happen.
MONTAGNE: Why would anyone want to be saddled with the burden of these toxic assets? Is a bad bank a good investment?
Dr. JOHNSON: Well, not really. I mean, it's not something that you would put your money into. The government is doing this in order to clean up the banking system because we need a healthy banking system, and the government is going to lose some money on this, hopefully not that much money if it's done right and done carefully. It's not something that private investors will touch with a barge pole right now; hence the problem. If you clean up the banks' balance sheets and create some better banks to resume lending to the real economy, that's the heart of the strategy.
MONTAGNE: So, it - the government could only, you think, recoup some of its losses, meaning not all of the taxpayer dollars that go into this?
Dr. JOHNSON: Absolutely. So, the basic point is this, that the cost to the taxpayer of cleaning up a banking system when you have massive failure around the world - experiences that cost you and me between 10 and 20 percent of GDP. So, that's the addition to government debt that's going to come out of this. That's a lot of money, but it's manageable. We can afford it. U.S. doesn't have that much debt to start with. As long as we get it right the first time, we'll be OK.
MONTAGNE: How do we know this will work?
(Soundbite of laughter)
MONTAGNE: I mean, that the remaining good banks will, in fact, survive and resume lending.
Dr. JOHNSON: Well, we don't know. Every - there's no way to know. We're in completely unchartered territory here. This, as part of a broad comprehensive approach with a strong fiscal stimulus and a housing-refinance program - I think both of those are pretty much done deals - the three legs to this strategy, if they have a large bank recapitalization piece to it and a balance sheet cleanup, it will most likely work. No magic bullets, though. I don't promise that you get credit resuming its growth within six to 12 months, but over a two-to three-year horizon, this will work.
MONTAGNE: If a bad bank is created, is there a place - I mean, I know they're not going to go out there and build it with, you know, brick and mortar exactly, but is there a place that this money goes?
Dr. JOHNSON: Sure, you'd have to create an entity, a financial institution of some kind. The good news is there's lots of experienced professionals looking for jobs in the financial-management industry right now. So, no trouble at all stocking it with absolutely top talent.
MONTAGNE: Simon Johnson is professor at MIT's Sloan School of Management, and a former chief economist at the International Monetary Fund. Thanks very much.
Dr. JOHNSON: Thank you.